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Australian Government Solicitor

 

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Legal Briefing

Number 41

27 April 1998

THE YEAR 2000 PROBLEM AND THE COMMONWEALTH

What is the Year 2000 Problem?

Early computer programmers dispensed with the two digits '19' when signifying the current century in computer programs. This made programming easier and quicker, creating more valuable space and thereby saving millions of dollars. (The term 'system' in this briefing is used to collectively refer to computer software and/or embedded systems which utilise a microchip.) Although people thought that these systems would be replaced by the turn of the century, many of the systems still exist, evolving into new programs or hidden within newer systems.

When '99' changes to '00' in the first seconds of the year 2000, most computer systems - unless previously made year 2000 compliant - could fail by:

  • rejecting entries
  • computing erroneous results, or
  • simply not operating.

In developing a solution, it is not possible to produce a standard date correcting program because each system produces a different pattern of errors. Each line of code must be checked and corrected. The year 2000 problem may be counteracted by modifying existing systems or, where it cannot be fixed through modification, by replacing non-compliant systems. Extensive programming is required in order to scan each line of code to locate date and clock fields for correction. Extensive testing is then required to check the modifications.

The Commonwealth needs to ensure that its systems are Year 2000 compliant. Sound project management and effective contracting are essential. Given the diversity and scale of its operations, the magnitude of achieving year 2000 compliance within the Commonwealth is significant. This briefing discusses the risk for the Commonwealth and its agencies under general liability and trade practices, and contractual issues relating to year 2000 solutions.

Risk for the Commonwealth and its Agencies

The Commonwealth and its agencies may be liable in negligence for damages or loss caused by a year 2000-related computer systems failure. Officers employed by the Commonwealth or agencies may also be personally sued and be held personally liable for a year 2000 failure.

If a Commonwealth agency is a corporation its executive officers also have obligations of duties of care and diligence (which extend to the year 2000 problem) under the corporations law.

Possible Damage

A year 2000 failure may cause damage in the nature of physical injury, property damage, or it may be in the nature of purely economic loss (where the loss is financial only and is not consequent upon property damage or physical injury).

Circumstances where a year 2000 failure may cause physical injury or death may include:

  • the functional failure of building facilities owned or occupied by the Commonwealth, such as the failure of lifts and warning or security systems
  • the malfunction of transport or navigational systems, or
  • the failure of building or emergency systems.

Circumstances where a year 2000 failure may cause purely economic loss might include:

  • the miscalculation of an individual's benefits and entitlements
  • a misdirection of funds through systems of direct crediting and direct debiting, or
  • a breakdown in communication systems causing business losses.

These are examples only and each agency should identify what risks the year 2000 problem could present in relation to its own operations.

Liability for Third Parties

The Judiciary Act 1903 removed the Crown's traditional immunity from suit in tort and contract. The effect of the removal of that immunity is that the Commonwealth can be sued for its tortious acts and for the tortious acts of its officials and agents.

At common law, liability in negligence will arise if a person who owes another person a duty to take reasonable care breaches that duty, and reasonably foreseeable and proximate damage results.

After the decision in Northern Territory of Australia v Mengel, governments and public officers are liable for their negligent acts and omissions in accordance with the same general principles that apply to private individuals.(1)

There is clear potential for the Commonwealth (and Commonwealth agencies) to be liable in negligence for claims arising from loss or damage attributed to a year 2000 failure.

The year 2000 problem presents a unique and novel occurrence as the technical reasons which have given rise to the problem have not been encountered before. Accordingly a court will be presented with a new category when determining the existence or otherwise of a duty of care.

However, categories of negligence are never closed,(2) and courts will consider whether the risk of damage was reasonably forseeable and whether there was a sufficient relationship of proximity between the plaintiff and the defendant.

Foreseeable Risk and Duty of Care

It has been acknowledged for some time that computer systems that are not year 2000 compliant may malfunction at the turn of the century. As the year 2000 draws nearer the level of awareness relating to the impending problem has increased.

This advance warning will make it difficult for a defendant to argue that it was not reasonably foreseeable that a plaintiff might suffer damage by reason of a computer system failure attributed to year 2000 non-compliance.

Commonwealth agencies need to identify the risks which the year 2000 problem poses to their particular operations and activities. Some of the Commonwealth's operations will present greater risk than others.

In those instances nothing short of replacement of the non-compliant systems may be considered sufficient to discharge the duty of care (particularly if it was considered that the modification of existing software would not be sufficiently foolproof). However in most cases existing systems may be modified.

Assuming a duty of care can be established, liability in negligence will depend on whether the Court considers that the Commonwealth has reasonably done everything possible in order to avoid or lessen the plaintiff's injury or loss. Where no action has been taken and injury or damage ensues, it will generally be difficult to assert that the year 2000 failure was unavoidable, as solutions now exist.

A claim for indemnity, however, will lie where the Commonwealth can, through a contractual right, shift the full extent of its liability onto another party, such as a software contractor that provided a year 2000 compliant warranty to the Commonwealth.

Potential Liability under the Trade Practices Act

As a general proposition, the Commonwealth could be liable for damages under the Trade Practices Act 1974 (the TPA) if (in its trading activities) it misleads or deceives, or falsely represents to a person that its software or a particular company's software is year 2000 compliant when it is not, and that person suffers loss or damage. An example would be where the Commonwealth or an agency is selling software or is involved in its distribution.

The provisions of the TPA only apply to the Commonwealth or its agencies if they are engaged in business activities. Possible causes of action against the Commonwealth under the TPA could be:

  • Under section 52, businesses are required to tell the truth or refrain from giving an untruthful impression.
  • Under section 53, a corporation is prohibited from making certain prescribed false representations in respect of goods or services it is supplying. Unlike section 52, a contravention of section 53 constitutes an offence and is punishable by a fine.

Although the Commonwealth is not liable to be prosecuted for an offence under the TPA, an authority of the Commonwealth is exposed and actions for pecuniary penalty or a prosecution may be brought against it by the Australian Competition and Consumer Commission.

  • Under division 2 of part V, some conditions and warranties are implied in contracts for the supply of goods and services to consumers as defined under the TPA.

In relation to year 2000 compliance, a relevant condition would be that software products should be fit for their purpose beyond the turn of the century.

Personal Liability of Officers

In the absence of statutory immunity, officers employed by the Commonwealth or agencies may be personally sued and be held personally liable. The fact that an employer is vicariously liable for the negligence of an employee provides no legal protection to an employee because, at common law, the employer has a right to obtain a full contribution from the employee where the employee is wholly at fault.(3)

The High Court recently confirmed this principle in FAI General Insurance Co Ltd v A R Griffiths Sons Pty Ltd.(4)

Under new financial legislation, the position in relation to the provision of legal assistance to officers varies according to whether the person is employed with an 'agency' to which the Financial Management and Accountability Act 1997 (FMA Act) applies or is employed with a 'Commonwealth authority' or 'Commonwealth company' to which the Commonwealth Authorities and Companies Act 1997 (CAC Act) applies.

For persons employed where the CAC Act applies, the authority or company is expected to indemnify their officers (see Finance Circular 1997/19). The position for persons employed where the FMA Act applies (which covers agencies which have no separate financial existence from the Commonwealth, including departments), is set out in the recently announced policy entitled Commonwealth Policy for Assistance to Officials in Relation to Legal Proceedings. (5) The policy states in paragraph (5) that assistance would be provided where the official was acting reasonably and responsibly in the interests of the Commonwealth.

Personal Liability of Directors and Executive Officers

The year 2000 problem may result in loss to a Commonwealth authority. Avoiding that loss will depend, among other things, on the quality of decision-making by the directors of the corporation (or the executive officers of the authority). Generally, Australian courts will not review the business judgment of directors unless the results are such as to indicate an actual breach of the duty of care which a director owes to the corporation. Such duties arise through general law as well as from statute.

In the case of general law the obligations may arise from contractual obligation (where the director is executive director, employed under a contract of service), as well as from common law and equity. In the case of statute, the corporations law imposes duties of care and diligence.

The position is virtually the same for executive officers of Commonwealth authorities. The CAC Act imposes the same requirements in relation to care and diligence as the corporations law. There is also some authority for the proposition that, as for company directors, executive officers of Commonwealth authorities would be under a general law duty to exercise reasonable skill.

Whether or not a director will be personally liable for loss will depend whether their behaviour failed to reach the standards of care, skill and diligence required by the law. That standard will vary on the basis of a number of factors. The test varies according to the origin of the duty (general law, contract, statute) and the type of duty (care, skill, diligence).

At general law, a director is expected to exercise such care and diligence as an ordinary person might be expected to exercise in looking after their own interests. The statutory test (in the Corporations Law at section 232(4) requires a director or executive officer to exercise such care and diligence as a reasonable person 'in a like position in a corporation would exercise in the corporation's circumstances'. There is a similar provision in the CAC Act at section 22(4) in respect of directors and officers of Commonwealth statutory authorities.

In relation to skill, there is a difference in what is expected of executive directors compared with non-executive directors. In the case of non-executive directors, the general law provides virtually no objective test (compared with other professions such as medicine or engineering). This is because historically, there has been no body of professional learning associated with being a director.

Nevertheless, where a director does possess special knowledge or experience, he or she is expected to use that in the affairs of the corporation. In the case of executive directors, however, the existence of a contract of service means that there is an express or implied contractual undertaking by the director, that they have the skills required for the performance of the job, including appropriate skills in financial management. No statute provides any requirement or test in relation to the level of skill which must be exercised by a director.

Implications for Clients

The case law has led to some statements of what might be expected of directors in a positive sense, although this relates to financial management rather than the issues raised by the year 2000 problem. A director is expected to:

  • have at least a certain minimum level of knowledge and continuing understanding of the business of the corporation
  • have at least a minimal knowledge of financial statements and reporting obligations, and
  • attend board meetings and monitor the financial status of the corporation.

Where the decision-making relates to managing risk in relation to a technical matter, such as the year 2000 problem, the formulation of the statutory duty of care and diligence referred to above gives a useful guide to the standards which might apply.

What constitutes an acceptable standard of care and diligence will depend very much on what measures other corporations have adopted in similar circumstances, and on the specific role that particular directors have in such a company.

The general position may be different where a director appointed to the board has specific expertise and knowledge in relation to the technical area in question, or where a director is appointed for the purpose of advising the board on these issues. In such a case the standard which the person is judged against would be subjective and therefore higher. Where such a director is an executive director, their contract of service may impliedly or expressly provide for the exercise by that director of skills at a particular level.

Contractual Issues Relevant to the Year 2000 Problem

Management

The real key to solving the year 2000 problem lies in management. While many Commonwealth information technology functions will be outsourced by the year 2000, agencies cannot rely on contractors to provide solutions under outsourcing arrangements. Decisions need to be made now on a range of matters. Existing systems need to be audited and decisions taken about systems owned by agencies. With systems that have been supplied from software houses as licensed software, agencies need to ascertain and have confirmed when the suppliers will be able to deliver their year 2000 compliant solutions. The software will need to be integrated with all the other software that is required for the operation of an agency's solutions.

This will often mean that agencies will need to negotiate with their software suppliers about a large range of matters including the extent of year 2000 compliance, delivery dates, compatibility with other products, acceptance testing and the extent to which the solution is warranted etc. Agencies will also need to make decisions about replacing existing systems with new solutions. This will also involve the management of issues such as new working arrangements, training etc that come with the integration of new products. In other circumstances managers may need to take decisions about whether particular functions should be performed at all or whether they should be outsourced.

With all these changes taking place with the software that agencies need for their business, it may be necessary to engage an external organisation to manage audits, reviews of terms and conditions of existing licences and advise on strategies for the implementation of changes to an agency's network. These are important tasks (with a very limited timeframe) that will need to be performed in the market in which your agency will be competing.

Agencies are finding it increasingly harder to get contractors to perform this work and are having to take on significant risks which they have previously passed on to contractors. This means that it is vital that agencies have good project management and effective contracts in place.

Clauses in Existing Contracts

The clauses in the standard Commonwealth common use contracts, even before the year 2000 clause was added, provide many features that are designed to protect the interests of the customer. In the case where the contractor is continuing to supply maintenance to licensed software products there is likely to be at least an implied understanding that the software will be made compliant prior to the year 2000. Those contracts also contain a requirement that the product be fit for the purpose and comply with the customer's functional specification. While these concepts operate from the time the contract was entered into, they may well have continuing relevance without the need for a specific reference to the year 2000.

Managing Year 2000 Contract Disputes

In general terms, the Commonwealth may take action against a contractor under contract law through the terms and conditions of the contract or through implied terms of the contract.

There are two main issues to consider:

  • existing contracts without mention of year 2000 compliance, and
  • information technology contracts being executed now during the lead-up to the year 2000 which contain the year 2000 warranty

and what action may be taken in either case should there be a failure of the product or service provided under those contracts.

Termination

While every effort should be taken to negotiate year 2000 issues with contractors there may be a need to enforce agencies' rights. Rights under a contract normally include termination for breach or repudiation and recision for misrepresentation or mistake. These rights should be contained in the clauses of the contract. They vary depending on the terms of the contract and may be subject to certain restrictions, such as the refusal to allow the enforcement of penalty clauses, as well as general principles of equity. These remedies are, however, only useful when the relationship between the parties has broken down.

No matter how serious a breach of contract may be it does not automatically lead to the right to terminate the contract unless the parties have clearly expressed an intention, through the terms of the contract, that this should be the result. Termination is a matter of election on the part of the party not at fault which implies that they are entitled to terminate for breach. The party who takes steps to terminate must follow the process as described in the contract.

Remedies for Breach

There are two types of breach of contract to consider: failure to perform, and anticipatory breach. A contractor may fail to perform, without lawful excuse, by its failure to discharge a contractual obligation at the time specified within the contract period for that performance.

An anticipatory breach would occur when the Commonwealth justifiably terminates the contract prior to the time agreed by the parties for performance under the terms of the contract. The termination will be justified if the words or conduct of the contractor or the contractor's actual position gives rise to a repudiation of the obligation to be performed, or indicates that the contractor has been prevented from performing the contract.

The major distinction here is that there must be a failure to perform at the expiry of the time for performance, whereas an anticipatory breach precedes the time of performance. Further, a failure to perform does not necessarily give rise to a right to terminate whereas an anticipatory breach arises on termination of the performance of the contract.

In relation to the year 2000 problem, the user of the product will know there is a breach during or after 1 January 2000. However, in the latter case the user will know before that date.

The most common remedies for breach of contract are:

  • an award of damages, including liquidated damages and recovery of sums specified under the contract
  • specific performance, and
  • injunction.

Damages

The remedy of damages is not dependent on any term in the contract expressly conferring the right of recovery. The failure to discharge an essential term or primary contractual obligation may give rise to a secondary obligation to provide compensation implied by law in the absence of a term to the contrary. The Commonwealth does not have to terminate in order to recover damages for breach.

However, the Commonwealth must terminate in cases of anticipatory breach where no right to damages accrues unless and until termination occurs.

Specific Performance

Specific performance will not be ordered unless a breach of contract has already occurred. The fact that the contract is breached means that the plaintiff has a remedy in damages, and the main basis for ordering specific performance of the contract is that a damages award is, in the circumstances, an inadequate remedy.

Recent court decisions indicate that this form of remedy is difficult to obtain. For the remedy to be ordered, the whole contract must be the subject of the order unless the order relates to a severable part of a severable contract. However, specific performance may be a remedy the Commonwealth might seek when dealing with a year 2000 problem. Commonwealth agencies may seek an order requiring the contractor to achieve year 2000 compliance with its product or service.

Implied Terms

The law in relation to implied terms in a contract is particularly important to the Commonwealth's position. There are many IT contracts in existence throughout Commonwealth agencies relating to products and services that will be affected by the year 2000 problem. These contracts often do not contain a year 2000 compliance clause or any warranty or guarantee in relation to possible
year 2000 problems.

A court will imply a term into a contract for the following reasons:

  • to give business efficacy to a contract - that is to ensure that a contract will operate in a business context
  • when it is apparent that from the nature of the contract itself or the obligations that it creates that a term was meant to be included and is therefore implied into the contract, and
  • when there may be a statutory obligation missing from the contract and therefore a court will imply a term so that the contracting parties fulfil their statutory obligations.

Reasonableness and policy are more important to legal implication and a term may be implied by law, on the ground that it is reasonable to do so, even though the 'business efficacy' and 'obviousness' criteria of terms implied in fact are not satisfied.
A court may consider that year 2000 compliance was reasonable, particularly when the contract was concluded in the latter years of this century. This may be the case even though a contractor may argue that it was not considered effective business practice at the time.

However, it should be noted that in a case where the materials of a particular brand were specified by the customer it was found that it was unreasonable to imply a warranty in the contract.(6) This is often the case when Commonwealth agencies specify their preferences for particular IT products.

ISSN 1448-4803 (Print)
ISSN 2204-6283 (Online)

The material in this briefing is provided for general information only and should not be relied upon for the purpose of a particular matter. Please contact the Legal Practice before any action or decision is taken on the basis of any of the material in this briefing.

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